Options market positioned for 10-year U.S. Treasury yield to hit 5% soon By Reuters

By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) – Investors in the futures options market are betting that the benchmark will be as high as 5% in the near term, reflecting concerns that the policies of the incoming Trump administration will increase an already tight fiscal deficit inflated and revive inflation.

Traders are eyeing that key 5% level in the 10-year note, which, if hit, could be bad news for US stocks, as it was in October 2023 when the 10-year yield peaked at 5.02%. That coincided with the benchmark falling to a five-month low.

Higher interest rates generally also mean increased borrowing costs for consumers and businesses.

In swaptions, or options on interest rate swaps, the market is also indicated at the higher 10-year rates, although it is not as simple as those on the futures of the Treasury.

As President-elect Donald Trump approaches his Jan. 20 inauguration, market participants have become increasingly anxious about his promise to impose sweeping tariffs on imports, a move widely seen as inflationary. , since they are betting that Treasuries will sell, pushing yields higher.

“It’s about the unknowns and the policy fog,” said Chip Hughey, managing director of fixed income at Truist Advisory Services in Richmond, Virginia. “That uncertainty revolves around the scope of tariffs and what that may ultimately mean for inflation.”

Tax cuts are also one of Trump’s campaign promises, which should benefit consumers and businesses in general. But if the tax cuts are not financed by spending reductions, they will likely expand the federal deficit. This means more Treasury debt issuance will flood the market to manage the spending gap, pushing interest rates higher.

Analysts say open interest, the amount of outstanding positions held by traders, is building in the March contract for 10-year Treasury futures options, with strikes in price levels of 105 to 106, according to traders, citing their data on Thursday. Those shots are aimed at the 10-year yield that hits between 4.75% and 5.00%.

Treasury put options are typically used to position for a decline in bond prices leading to higher implied yields.

The U.S. 10-year yield was little changed on Thursday at 4.689%, after hitting a roughly eight-month peak of 4.73% on Wednesday.

BARISH FEELING

More puts were bought than call options that gain value when futures prices fall and implied yields rise. This is especially the case in the March contract where the put-to-call ratio of 1.23 suggests bearish sentiment on 10-year Treasury note futures.

Put premiums, or price of the options contract, are even more expensive than those on calls, with a ratio of 1.69 in favor of puts.

“A 10-year yield of 5% is not our forecast, but I don’t think it’s out of the realm of possibility that we could get there,” said Jan Nevruzi, US rates strategist at TD Securities in New York, citing Trump’s policy. and the Federal Reserve indicated it might pause its rate-cutting cycle.

“With the higher change in rates, we’ve seen trades around options that are close to the 5% yield. It’s certainly a psychological barrier that people will look to trade around.”

In the swaptions market, the implied volatility of one-month options on 10-year swap rates had increased to 24.06 basis points (bps) on Thursday, from 20.89 bps on December 12. signaling activity growth expectations on this maturity in the short term. terms. Rate swaps, which typically track Treasuries, measure the cost of exchanging fixed rate cash flows for floating rate ones, or vice versa. They are used by investors to hedge interest rate risk.

Volatility is a key input into the price of an option. The higher the volatility, the greater the uncertainty over a certain period.

As volatility rises, there are bets on a move higher in 10-year exchange rates in one month paying for so-called “elevated payer strikes” of around 25 bps more on 10-year options, analysts said. It’s a bet that 10-year exchange rates will be 25 bps higher in a month, and that’s likely because 10-year Treasury yields will likely rise as well. Current 10-year swap rates are 4.18%.

The cost of that 25 basis point strike rose to 23.13 bps on Thursday, from 20.8 bps on December 12, when it fell to a five-month low.

“The implied volatility on swaptions is skewed towards higher rates,” said Amrut Nashikkar, managing director of fixed income strategy at Barclays (LON:) in New York. “What that tells you is that there is a demand for positioning against higher rates and there is a risk premium that people are willing to pay to buy protection against a higher move.”